Banks are invariably faced with different types of risks that may have a potentially adverse effect on their business. Banks are obliged to establish a comprehensive and reliable risk management system, integrated in all business activities and providing for the bank risk profile to be always in line with the established risk propensity.
Risk management system comprises:
• Risk management strategy and policies, as well as procedures for risk identification and measurement, i.e. for risk assessment and risk management;
• Appropriate internal organization, i.e. bank’s organizational structure;
• Effective and efficient risk management process covering all risks the bank is exposed to or may potentially be exposed to in its operations;
• Adequate internal controls system;
• Appropriate information system;
• Adequate process of internal capital adequacy assessment.
In their operations banks are particularly exposed to or may potentially be exposed to the following risks:
• Liquidity risk is the risk of potential occurrence of adverse effects on the bank’s financial result and capital due to the bank’s inability to meet the due liabilities caused by the withdrawal of the current sources of funding, that is, the inability to raise new funds (funding liquidity risk), aggravated conversion of property into liquid assets due to market disruption (market liquidity risk);
• Credit risk is the risk of potential occurrence of adverse effects on the bank’s financial result and capital due to debtor’s default to meet its obligations to the bank.
• Residual risk is the possibility of occurrence of adverse effects on the bank’s financial result and capital due to the fact that credit risk mitigation techniques are less efficient than expected or their application does not have sufficient influence on the mitigation of risks to which the bank is exposed;
• Dilution risk is the possibility of occurrence of adverse effects on the bank’s financial result and capital due to the reduced value of purchased receivables as a result of cash or non-cash liabilities of the former creditor to the borrower;
• Settlement/Delivery risk is the possibility of occurrence of adverse effects on the bank’s financial result and capital arising from unsettled transactions or counterparty’s failure to deliver in free delivery transactions on the due delivery date;
• Counterparty credit risk is the possibility of occurrence of adverse effects on the bank’s financial result and capital arising from counterparty’s failure to settle their liabilities in a transaction before final settlement of transaction cash flows, or, settlement of monetary liabilities in the transaction in question;
• Market risks entail foreign exchange risk, price risk on debt securities, price risk on equity securities, and commodity risk;
• Interest rate risk is the risk of possible occurrence of adverse effects on the bank’s financial result and capital on account of banking book items caused by changes in interest rates;
• Foreign exchange risk is the risk of possible occurrence of adverse effects on the bank’s financial result and capital on account of changes in foreign exchange rates;
• Concentration risk is the risk which arises directly or indirectly from the bank’s exposure to the same or similar source of risk, or, same or similar type of risk;
• Bank exposure risks comprise risks of bank’s exposure towards a single person or a group of related persons.
• Bank’s investment risks comprise risks of its investments into non-financial sector entities and in fixed assets and investment property.
• Country risk is a risk relating to the country of origin of the person to which the bank is exposed, that is, the risk of negative effects on the bank’s financial result and capital due to the bank’s inability to collect receivables from such person for reasons arising from political, economic or social circumstances in such person’s country of origin.
• Operational risk is the risk of possible adverse effects on the bank’s financial result and capital caused by omissions (unintentional and intentional) in employees’ work, inadequate internal procedures and processes, inadequate management of information and other systems, as well as by unforeseeable external events. Operational risk also includes legal risk.
• Legal risk is the risk of loss caused by penalties and sanctions originating from court disputes due to breach of contractual and legal obligations, and penalties and sanctions pronounced by a regulatory body.
• Risk of compliance of the bank’s operations is the possibility of occurrence of adverse effects on the bank’s financial result and capital as a consequence of failure to comply its operations with the law and other regulations, standards of operations, anti-money laundering and counter-terrorist financing procedures, and other procedures as well as other acts governing the bank’s operations, particularly encompassing the risk of sanctions by the regulatory authority, risk of financial losses and reputational risk.
• Reputational risk relates to the possibility of the occurrence of losses due to adverse effects on the bank’s market positioning.
• Strategic risk is the possibility of occurrence of adverse effects on the bank’s financial result and capital due to the absence of appropriate policies and strategies, their inadequate implementation, as well as changes in the environment where the bank operates or absence of appropriate response of a bank to those changes.
How Mortgages Are Approved
When you apply for a mortgage, your lending specialist will forward your application and the supporting documentation to an underwriter. It’s the underwriter’s responsibility to review your loan scenario and the supporting documentation to ensure that it meets the loan program guidelines and to determine whether or not you qualify for the loan.
The underwriter looks at your information with these basic criteria in mind:
• Your ability to repay the loan. This requirement basically asks, “Is your income enough to cover the new mortgage payment and all your other monthly expenses?” To figure this out, lenders use your debt-to-income ratio (DTI). Most lenders want your debt-to-income ratio to be 36% or less, but the ratio that works best for you is the one that you can comfortably afford.
• Your likelihood to repay the loan. Your payment history and credit score are indicators to lenders of your likelihood to make payments in the future.
• The home’s value. The underwriter carefully looks at the value of the home you’re purchasing (based on a professional appraisal ordered by your lender) to verify that it meets or exceeds the purchase price. This will also help them understand whether the loan-to-value ratio (LTV) fits within the loan program guidelines. To qualify for a conventional loan, most lenders require you to have a loan-to-value ratio of no more than 80-95%. The higher your home’s value and the less you owe on it, the lower your LTV.
• The source and amount of funds for your down payment. If you have a down payment of less than 20%, you will typically be required to pay private mortgage insurance (PMI), which increases your monthly mortgage payment. The underwriter will review your documentation to estimate whether you have enough money to cover closing costs. You may also be required to have set aside 2 or more monthly mortgage payments as reserves, depending on the loan program and/or loan amount. Lenders typically require reserves to cover your mortgage payment in case of emergencies or unforeseen events.
Pros and Cons of Banks
While large banks can have lower customer service approvals due to their often impersonal service, many small or community banks have very good customer service. And, even if the customer service at larger corporate banks seems cold or robotic, it is often consistent due to uniform training practices (whereas credit union experiences may vary). Fees may be higher for banks, but there are no membership requirements. Additionally, banks generally have more branches, easier access, and better technological developments (such as apps, etc.) than credit unions. This has become increasingly important for users who often depend on mobile banking services. Banks can tend to be more convenient, depending on which you choose.
The large amount of managing money or cash, basically by huge private and government entities or organization is said to be Finance. It confines with the study and creation of such as;
• Money matters.
• Banking system.
• Credit system.
• Investments system.
• Assets and Liabilities.
This combination of all together that makes up Financial Systems. Finance can be superseded by the word Exchange. It is therefore said as exchange of available resources or art of managing various types of resources. Finance is so important today, it is said to be as soul of all our economic activities. Finance is a necessity for acquiring physical resources, which are very important and needed to accomplish productive economic activities and for carrying business functionalism such as;
• Sales Promotion.
• Pay Compensations.
• Unconfirmed Liabilities.
• Reason for uncertainty and many more.
Now in today’s situation, finance has become the most important natural function and inseparable part of our daily life process. Finance in more specific is solicited with the management issues such as;
• Owned funds generated from promoter contribution.
• Raised funds generated from equity share, preference share, etc.
• Borrowed funds generated from loans, debentures, overdrafts, etc.
Finance also at the same time, confines greater approach of managing the assets generated by the business and other valuable liabilities with better organized fashion.
There are 2 main types of finances such as;
• Debt finance is money borrowed from external source like bank.
• Equity finance were investing your own money from other stakeholders, interchange for partial ownership.
These procedures help in executing the financial planning of any business such as;
• Effect of plans evaluating on stock price and financial quotient.
• To raise the funds identifying exact means to execute systematically.
• Proper forecasting of sales.
• Estimation of assets required for supporting sales.
• Estimation of generated funds within the company.
• Estimation required for external funds.
Financial planning always should start before the beginning of any project and should be carried throughout its functioning period of time to have strong control over the finance.
Advantages and Disadvantages of Bank Loans
At some point, every business needs an outside source of capital to further growth. For small businesses and startups, there are a variety of ways to raise capital. One of those methods is bank loans, which, in the right circumstances, can benefit a business in the short and long-term.
Advantages of Bank Loans
• Low Interest Rates: Generally, bank loans have the cheapest interest rates. The rates you pay will be cheaper than other types of high interest loans, such as venture capital. Bank loans offer significantly lower interest rates than you will find with credit cards or overdraft.
• Flexibility: When you receive a bank loan, the bank will not provide a set of rules dictating how you spend the money. While venture capitalists and angel investors will restrict what you can do with the money, bank loans can provide you the flexibility to spend the money where you see fit. Whether you need capital to purchase new equipment, enter a new market, or carry out a new marketing plan, you can use the money from a bank loan.
• Maintain Control: You don’t have to give up equity to get a loan from a bank. Venture capitalists and angel investors typically require you to give them equity or some say in your company. However, this is only true if you make your payments to the bank on time.
Disadvantages of a Bank Loan
• Requires Profitability: While venture capitalists and angel investors usually take risks to invest in companies that haven’t yet proved profitable, banks will take no such risk. To be eligible, your company must be consistently profitable, which disqualifies the majority of startups.
• Complicated: Obtaining a bank loan is extremely time consuming. You will be required to fill out excessive paperwork, and the terms of interest will be quite complicated. The process will not be quick either, often, it takes several months to qualify and obtain capital from a bank. Compared to other financing options, bank loans serve as one of the most difficult to obtain.
• Collateral: Regardless of your profitability or how good your credit score happens to be, banks will need some form of collateral. Banks need to protect themselves in the case that you can’t make your payments.
Loan Agreement In Finance Banks
Loan agreements are binding contracts between two or more parties to formalize a loan process. There are many types of loan agreements, ranging from simple promissory notes between friends and family members to more detailed contracts like mortgages, auto loans, credit card and short- or long-term payday advance loans. Simple loan agreements can be little more than short letters spelling out how long a borrower has to pay back money and what interest might be added to the principal. Others, like mortgages, are elaborate documents that are filed as public records and allow lenders to repossess the borrower’s property if the loan isn’t repaid as agreed. Each type of loan agreement and its conditions for repayment are governed by both state and federal guidelines designed to prevent illegal or excessive interest rate on repayment. Loan agreements typically include covenants, value of collateral involved, guarantees, interest rate terms and the duration over which it must be repaid. Default terms should be clearly detailed to avoid confusion or potential legal court action. In case of default, terms of collection of the outstanding debt should clearly specify the costs involved in collecting the debt. This also applies to parties using promissory notes as well.
Purpose of a Loan Agreement
The main purpose of a loan contract is to define what the parties involved are agreeing to, what responsibilities each party has and for how long the agreement will last. A loan agreement should be in compliance with state and federal regulations, which will protect both lender and borrower should either side fail to honor the agreement. Terms of the loan contract and which state or federal laws govern the performance obligations required by both parties, will differ depending upon the loan type. Most loan contracts define clearly how the proceeds will be used. There is no distinction made in law as to the type of loan made for a new home, a car, how to pay off new or old debt, or how binding the terms are. The signed loan contract is proof that the borrower and the lender have a commitment that funds will be used for a specified purpose, how the loan will be paid back and at what amortization rate. If the money is not used for the specified purpose, it should be paid back to the lender immediately.
Other Reasons for Using Loan Agreements
• Borrowing money is a huge financial commitment, which is why a formal process is in place to produce positive results on both sides. Most of the terms and conditions are standard fare amount of money borrowed, interest charged, repayment plan, collateral, late fees, and penalties for default but there are other reasons that loan agreements are useful.
• A loan agreement is proof that the money involved was a loan, not a gift. That could become an issue with the IRS.
• Loan agreements are especially useful when borrowing or loaning to a family member or friend. They prevent arguments over terms and conditions.
• A loan agreement protects both sides if the matter goes to a court. It allows the court to determine whether the conditions and terms are being met.
• If the loan includes interest, one side may want to include an amortization table, which spells out how the loan will be paid off over time and how much interest is involved in each payment.
• Loan agreements can spell out the exact monthly payment due on a loan. It is safe to say that anytime you borrow or lend money, a legal loan agreement should be part of the process.